Volatility has been a mainstay in public markets for the past 15 months. As measured by the CBOE Volatility Index, commonly known as Wall Street’s fear index, expected volatility in the S&P 500 Index has been well above the historical mean. Spikes in the VIX signal investors’ apprehension about stocks due to elevated levels of fear or stress in the market. While stocks are up in the first quarter of 2023, markets are still experiencing turbulence tied to central bank monetary policy, geopolitical stress, and the recent string of bank failures in the United States.
Against this backdrop, here we list five portfolio management ideas that can help investors cushion volatility. These strategies may prove especially useful if you believe high inflation will persist for the rest of the year.
Be sure to check our Portfolio Management Channel to learn more about different portfolio rebalancing strategies.
1. Developed Market Stocks Over Emerging Markets
The outlook on developed economies isn’t great. The International Monetary Fund is forecasting a steep slowdown in economic growth for the advanced economies of North America and Europe, a fact that will likely put downward pressure on corporate sales and profits. However, Northern Trust Asset Management analysts still expect pockets of U.S. economic durability to limit or even prevent a U.S. earnings recession in 2023. And while volatility is still in play, investor sentiment is expected to improve for the rest of the year, especially if the federal funds rate plateaus or begins to decline.
In this environment, developed market stocks in established plays may offer more of a buffer against volatility than emerging markets, whose post-COVID-19 recoveries are expected to be bumpy.
2. High-Yield Bonds
One of the most obvious places to park money today is in high-yield bonds, whose issuers benefit from robust credit quality and lower rate sensitivity than other bonds. High-yield bonds currently offer yields of between 5% and 8%, providing investors with a steady source of income that’s often viewed as the best hedge against volatility and inflation. While default rates are forecast to rise off record lows, they’re not expected to exceed the long-term average, thanks to strong cash flows on the part of the issuers.
3. Natural Resource Stocks
China’s reopening is expected to offer many investment opportunities for the rest of 2023 as the world’s second-largest economy returns to full capacity following extended COVID-19 lockdowns. A more active China means higher demand for natural resources, a sector that has grown more resilient to economic downturns and instability. In addition to acting as an inflation hedge, natural resource companies may benefit significantly if China’s reopening proves successful.
According to Goldman Sachs, the principal theme in China’s economy and stock market in 2023 will gradually shift from reopening to recovery as the country embarks on a growth phase before the end of the year.
4. Low-Cost Index Funds
Market instability often leads to indecision, keeping investors on the sidelines longer than they want. For investors having trouble selecting stocks or mutual funds, opting for low-cost index funds with broad market exposure to established securities may not be a bad idea. Index funds invest in a basket of stocks or bonds tracking an underlying benchmark, a strategy that has historically proven easier to manage and with better results than selecting individual securities. Index funds usually have a much lower expense ratio than actively managed funds, giving investors the added benefit of keeping costs under control as they ride out volatility.
5. Allocation to Gold
While gold has been a perennial underperformer for the past decade, the precious commodity is off to a good start in 2023, owing to a weaker economy and declining U.S. dollar. Gold is still considered one of the best hedges against inflation, making it a viable option for investors skeptical about the Federal Reserve’s ability to engineer a soft landing. By most measures, the consumer price index and other inflation metrics are expected to remain well above the Fed’s 2% target for the foreseeable future. Now that the dollar is on the decline, gold may actually benefit from a higher inflationary environment.
Take a look at our recently launched Model Portfolios to see how you can rebalance your portfolio.
